When the shockingly bad employment data was released on Friday, with just 38,000 new jobs added in May and downward revisions to the April and Mach data as well, it sent vibrations through the financial markets. The U.S. dollar dropped and stocks, gold and bonds rallied.
The fact that Federal Reserve Chair Janet Yellen spent so much time discussing the labor situation in her speech on Monday seemed to confirm we can expect lower interest rates for longer.
The Chicago Mercantile Exchange tracks the probability of a rate hike each day using futures’ prices. Prior to Friday’s report, futures traders put the probability of a rate hike at 21% in June and 58% in July. Those estimates have dropped to 4% and 27%, respectively. In fact, traders are pricing in a less than 50% probability of a rate hike until December.
No rate hikes in June or July may sound like a good thing for stocks in general, but that may not turn out to be true, especially for the financial sector. A lower probability of rate hikes in the near term has compounded the problems banks and brokers are facing from a flattening yield curve. When the yield curve flattens, it is usually associated with fears that economic growth will also be low.
Banks and brokers make money off the yield spread between long-term and short-term interest rates. As that spread has narrowed over the past month, profit expectations within the financial sector have been looking worse. And, from a technical perspective, the stock we think is likely to lead the sector to the downside is Morgan Stanley (MS).
MS stock has been forming a large bearish wedge since February. The lower trendline of that pattern was retested again on Friday after the labor report. However, we expect that trendline to be broken to the downside in the near term as a bearish divergence on the MACD oscillator was confirmed this week.
Based on the size of the second “top” of the divergence, we suggest a downside price target of $24.21, equal to the 161.8% retracement level. Assuming the downside breakout still has momentum at that level, the next target is $21 based on the bearish wedge.
InvestorPlace advisors John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get one free month today by clicking here.
